Design Your Product Around Price

By Aarthi Rayapura November 14, 2016

Madhavan Ramanujam is a partner and board member at Simon-Kucher & Partners. He advises companies of all sizes, from startups to Fortune 500s, on monetization strategy and has helped bring numerous new products to market. His new book, “Monetizing Innovation: How Smart Companies Design the Product Around the Price,” co-authored with Georg Tacke, Co-CEO of Simon-Kucher & Partners, offers a practical approach to improve the odds of new-product success and illustrates the importance of putting the customer’s willingness to pay at the very core of product design.
Aarthi Rayapura caught up with him for a chat.

What exactly is the problem that your new book “Monetizing Innovation” addresses? Aren’t good innovations automatically successful in the marketplace?
Today, innovation is a clarion call for every business in every industry in every corner of the world. It’s the most important driver of growth and the most critical element that determines your survival in the marketplace.
However, successful innovation—as measured in dollars and cents—remains elusive. Companies invest substantially in
designing and building highly innovative products. Yet they struggle to monetize them. As a result, billions of dollars are
spent and lost every year. In fact, more than 70 percent of innovations fail to meet revenue or profit goals or fail entirely.
But it doesn’t have to be this way. We wrote “Monetizing Innovation” to give entrepreneurs and organizations tools and
frameworks to monetize innovation with confidence and certainty. In short, we are trying to help them go from hoping
they’ll make money on their innovations to knowing they will.

That’s fantastic! Can you tell us more about the 5 myths of product innovation that you describe in the book?
I find the most common myth to be “Build it, and they will come.” The belief is that if you build a great product, customers will buy it and pay fair value for it. Often entrepreneurs are so passionate about their product that they believe its merits will be self-evident to prospective customers; that the innovation is so exceptional that it will sell itself. But this isn’t what happens in reality because they forgot to address the question of monetization.
The other myths are that the new product must be controlled entirely by the innovation team working in isolation, a high failure rate of innovation is normal and even necessary, customers must experience a new product before they can say how much they’ll pay for it, and that, until the business knows precisely what it’s building, it cannot possibly assess what it’s worth.
Some people see monetization as dirty work, detrimental to true innovation. Why should big, bold new product concepts be hampered by stopping to ask for a price check? But if you don’t design your product around price, if you don’t understand how much your customers are willing to pay, failure is almost inevitable.

Designing the product around the price seems like a novel approach, some might even call it upside-down.
When most people hear the word “price,” they think of a number. That’s really a price point. When we use the term “price,” we are trying to get at something more fundamental—we want to understand the value that the innovation holds for the customer and its monetization potential. How much is the customer willing to pay? What would the demand be? Seen in this light, price is both an indication of what customers want and a measure of how much they want it.
Most companies postpone marketing and pricing decisions to the very end of product development. Price is just an afterthought, a last-minute consideration made after a product is developed, even though it’s the single most critical factor in determining whether a product makes money. “Monetizing Innovation” flips the “build it and then price it” mentality on its head: Market and price, then design, then build. I can’t stress this enough—design the product around the price. By putting customer demand and willingness to pay front and center in your product development process, you’ll change the game!

In the book, you talk about the types of innovation failures.Can you elaborate?
Sure, there are four of them. We call the first one “Feature Shocks.” These are new products that have been over-engineered with too many features! They end up increasing the cost and the complexity of the product. And the problem rears its head when customers don’t want them, or won’t pay extra for them. To avoid feature shocks, product development must be centered around customer needs and willingness to pay.

The second one is “Minivations.” These are innovations that sell themselves short because their developers didn’t realize just how much value their offerings provided to customers. And thus, they underestimated how much customers would be willing to pay for them and left big profits on the table.

How can a company know it has a minivation?
Check to see if your Sales team is easily meeting its targets with a new product. Also watch your channel partners—are
they reaping big margins from selling your product? Another indicator, especially for B2B businesses, is having too few customers asking to escalate deal discussions to higher levels in your company because they are dissatisfied with your price.

What are the other two types of failure?
The third one is what we call “Hidden Gems.” These are “Would-Be Winners” that never left the starting gate—Brilliant
ideas that live in limbo because companies don’t recognize the value of the product.
And the fourth is “Undeads.” Just like the world of science fiction, the business world has its own version of undeads—
products that came to market dead on arrival. These are products a company should have never launched—either they are an answer to a question that no one is asking, or they are the wrong answer to the right question.

So, how can companies avoid these mistakes?
Companies can avoid failure, but only if they play by different rules. The most important one is having in-depth pricing discussions with target customers long before the product development team begins to draw up the engineering plans, and certainly long before any manufacturing resources are committed and configured to building something. Those discussions need to center on determining precisely what features customers truly care about, are willing to pay for, and the price they are willing to pay.
And if you find a market willing to pay, don’t force a one-size fits-all solution on them. Your customers are different, so customer segmentation is crucial. But segmentation based on demographics—the primary way companies group their customers—is not actionable. You should build segments based on differences in your customers’ willingness to pay for your new product.
Lastly, choose the right pricing and revenue models. How you charge is often more important than how much you charge. If companies don’t start with having the pricing and willingness to pay conversations early, they end up establishing anchors and often those are hard to get away from. And then, they play constant catch-up with sub-optimal results.

Pricing takes on a whole new dimension for subscription companies where the goal is not only to monetize a new innovation, but to also nurture and grow a customer relationship. How can such companies know if they’ve got pricing right?

I couldn’t agree more. For subscription companies, it’s important to keep a good balance of landing and expanding customers. However, 90% of companies that claim to have a “land and expand” strategy, are only landing and not expanding.
The primary reason for this is companies tend to give the farm away and make the entry level or free product so attractive that there is little value for people to migrate to paid options. If you find more than 70 percent of your customers concentrated on the entry level subscription package, you have a monetizing innovation problem at hand. Ideally, if you think about a “good-better-best” subscription option, the majority of your customers should be concentrated in the “better” and “best” packages.

What are the pricing KPIs for subscription companies? What should we track?
The usual suspects include ARPU, MRR (ARR), and CLTV. However, the most successful companies go beyond just tracking financial KPIs. They track operational, customer, and sales KPIs as well to gauge the pricing and packaging performance of their products. For example, it’s important to track KPIs such as number of escalations, percentage deviation from target price, and win-loss ratio (for businesses that have a direct sales component). It’s also very important to track the conversion mix of subscription packages to ensure that customers are being up-sold over a period of time.

How can subscription companies know the time is right for a change in pricing, such as a price hike or the need for different packaging options?
Subscription businesses should check the relevancy of their pricing and packaging every year. If you have annual contracts, you must revisit the conversation by default, showcase additional products and, if possible, try to upsell. Another good time is when you have a healthy pipeline of functionality. It isn’t enough to simply understand the product-market fit. You need to understand product-market-pricing fit. Think of it this way—if you ask someone “do you like this feature?” you might hear a “yes” but if you ask the question “do you like this feature at $20?” the conversation changes.
Unless you put pricing and willingness to pay at the center of product-market fit validation, you might only hear what you want to hear! So the right time to think of monetization is when you have a whole bunch of ideas, so you can truly find out what your customers would need, value, and are willing to pay for.

Thanks for the insightful chat, Madhavan!
Thank you.

For more on pricing, listen to Madhavan Ramanujam speak on the Subscribed Podcast! And continue reading the latest issue of Subscribed Magazine here!